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Effectual Decision Making of Revolutionary Entrepreneurs

May 2009 Corporate 1 Comment

Entrepreneurs are a different breed, but what is this breed?  While some researchers have attempted to examine the behaviors of entrepreneurs, others look at the development path leading to entrepreneurship, and still others at their decision-making processes.  In most cases, one comes to the conclusion that entrepreneurs are unlike their counterparts in established companies.  But how?

Recently, Reed et al. examined the decision-making practices of highly successful entrepreneurs, individuals who have grown a company to $200 million or more in annual revenues, and contrasted their decision-making criteria between successful business executives in established businesses and novice entrepreneurs.  The results were striking.  They revealed that entrepreneurs tend to use a more effectual logic rather than predictive logic.

Issue Predictive Effectual
View of the future Predictive: The future as a continuation of the past.  Accurate prediction is both necessary and useful. Creative: The future is co-created (at least in part) by willful agents, which may include investors, partners, and customers who “pre-commit” to the venture.
Basis for taking action Goal Oriented: Goals, even when constrained by limited resources, determine subgoals and actions. Means Oriented: Goals emerge by imagining a course of action that begins from available means.
Risk and resource Expected Return: Pursue new opportunities based on the risk-adjusted expected value.  Focus on the upside potential. Affordable Losses: Pursue satisfactory opportunities without investing more resources than stakeholders can afford to lose.  Limit downside potential.
Attitude towards outsiders Competitive Analysis: Protect what you have and maximize your share of the opportunity. Partnerships: Share what you have with committed partners because relationships (particularly with shared rewards) shape the trajectory of the opportunity.
Attitude towards unexpected events Avoid: Surprise is bad.  Prediction, planning, and focus enable the firm to minimize the impact of unexpected events. Leverage: Surprise is good.  Imaginative rethinking of possibilities transforms the unexpected into new opportunities.

Effectual logic is “focused on intangible resources, the co-creation of value, and relationships.”  It evolves out of the resources one has at his or her disposal, expands by forming relationships with others which are nurtured in an effort to co-create a future which rewards both parties.  Effectual logic welcomes surprises, taking advantage of unexpected events to transform them into new opportunities.  In essence, it is an exploratory logic, wherein active agents explore the business horizon and actively create a future in which they can prosper.

Predictive logic, in contrast, is focused on exploiting established correlations between causes and effects in order to make investment opportunities that maximize future returns.  It directs actions from a goal-oriented viewpoint, where goals lead to action steps, milestones, and predictable results.   Predictive logic eschews surprises.  Executives using predictive logic develop a gut reaction to surprises as an undesired roadblock in their progress towards well-established actions and desired outcomes.

It may not be that entrepreneurs reject predictive logic or that managers of established organizations reject effectual logic, but rather that their dominant decision-making patterns are different, which leads to very different actions and results.

For instance, with respect to market research, managers of established businesses tended to find market research to be valuable in guiding their investment decisions while highly-successful entrepreneurs tended to eschew market research in favor of anecdotal evidence or past experiences.

Likewise in pricing, successful entrepreneurs tend to price new products according to the willingness to pay of a few highest-value customers while established business managers tended to look for price points which would attract a larger base of customers.

When it comes to financial investments, predictive logic drives investments based on maximizing risk-adjusted returns.  In contrast, effectual logic limits investments to acceptable losses in order to preserve the entrepreneur, so they may live to fight again another day.

While effectual logic yields higher flexibility, it also reduces the security gained by using known predictability.  Effectual logic may enable faster changes in business plans, reacting to the formulation of new partnerships and continual re-examination of new opportunities.

Yet these same exact attributes imply that effectual logic does not take a plan-and-do approach to strategy formulation.  It is exploratory.  This highly flexible and morphable approach  can lead to an apparent schizophrenic strategy, driving organizations mad and leaving customers confused.

With predictive logic, large organizations can be directed to move forward within the marketplace.  Efficiencies are created with repeated routines, the development of expertise, and accelerated reactions through known expectations of challenge-action-result connections.

For an organization, predictive logic provides some serious advantages to effectual logic.  It is difficult to redirect organization on a dime to react to potentially fleeting opportunities.  Individuals may miss cues, reducing productivity in important and established tasks, leaving the company in disarray.

To validate that effectual logic works, we have the fact that highly successful entrepreneurs use it.  Yet one must also state that this way of thinking is different from the dominant approach used in established businesses.

It is hard to imagine that every business-person would want to be an entrepreneur, willfully relinquishing the value of predictive logic in favor of effectual logic. It is a scary way to live.  Couple this with the knowledge that most new ventures fail, it is hard to understand why so manypeople choose this path.  And yet, we do.

Moreover, in the entrepreneurial world, we are acting as explorers, identifying and creating new opportunities for our businesses, in order for ourselves to succeed.  In contrast, established businesses act more as exploiters, using past patterns and access to resources to exploit established opportunities with more reliably predictable results.

So, which breed are you?  Which paradigm describes your company’s dominant business profile?  An entrepreneur using effectual logic or an established business using predictive logic?

Example Firms Using Effectual vs. Predictive Logic

Effectual Predictive
3M Vienna Beef, LTD
Xilinx SABMiller plc
Facebook Molex
Starbucks (Early Years) Ashland Inc.
Adica Swagelok
E-Factor Harland Clarke
Mashington Group Autozone
Kilcullen Kaptial Partners Kimberly Clark
FYIndOUt Boeing

References

  • Saras Sarasvathy and Nicholas Dew, (2005) “Entrepreneurial Logics for a Technology of Foolishness,”  Scandinavian Journal of Management, 21 (4):  384-406.
  • Stuart Reed, Nicholas New, Saras Sarasvathy, Michael Song, & Robert Wiltback, (May 2009), “Marketing Under Uncertainty:  The Logic of an Effectual Approach,”  Journal of Marketing, 73 (May):  1-18.
  • Stephen Vargo and Robert Lusch (2004), “Evolving to a New Dominant Logic for Marketing,” Journal of Marketing, 68 (January):  1-17.


About the author

Tim J. Smith, PhD is the Managing Principal of Wiglaf Pricing, and an Adjunct Professor at DePaul University of Marketing and Economics. His most recent book is Pricing Strategy: Setting Price Levels, Managing Price Discounts, & Establishing Price Structures.

Tim J. Smith, PhD
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